Stock Analysis

Is C&A Modas (BVMF:CEAB3) A Risky Investment?

BOVESPA:CEAB3
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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies C&A Modas S.A. (BVMF:CEAB3) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for C&A Modas

What Is C&A Modas's Debt?

The image below, which you can click on for greater detail, shows that at March 2023 C&A Modas had debt of R$2.22b, up from R$1.71b in one year. However, it also had R$1.46b in cash, and so its net debt is R$761.6m.

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BOVESPA:CEAB3 Debt to Equity History May 13th 2023

How Strong Is C&A Modas' Balance Sheet?

We can see from the most recent balance sheet that C&A Modas had liabilities of R$2.77b falling due within a year, and liabilities of R$3.40b due beyond that. On the other hand, it had cash of R$1.46b and R$1.80b worth of receivables due within a year. So its liabilities total R$2.90b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the R$1.16b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, C&A Modas would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While C&A Modas has a quite reasonable net debt to EBITDA multiple of 1.5, its interest cover seems weak, at 0.87. This does have us wondering if the company pays high interest because it is considered risky. In any case, it's safe to say the company has meaningful debt. Notably, C&A Modas's EBIT launched higher than Elon Musk, gaining a whopping 464% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if C&A Modas can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, C&A Modas actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

We feel some trepidation about C&A Modas's difficulty level of total liabilities, but we've got positives to focus on, too. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. We think that C&A Modas's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for C&A Modas (of which 1 is a bit unpleasant!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.